Posts Tagged ‘Department Of The Treasury’

Buttonwood Summit Yields Sharp Criticism

Monday, October 19th, 2009


The Economist’s Buttonwood Gathering, a conference bringing together global regulators and bankers to discuss and debate new ideas and develop a new set of guidelines moving forward, has just taken place in New York. Michael Panzer, was in attendance and has kindly shared some of the more interesting quotes on his blog, as reported below.

Secretary Tim Geithner, United States Department of the Treasury:

“Generally, we did not do enough.” (Referring to the failure to address growing concerns over excessive risk-taking in the period leading up to the financial crisis.) [Editor's note: understatement of the year?]

Stephen Roach, Chairman, Morgan Stanley Asia:

Those who are looking for a “V”-shaped recovery are in for “a rude awakening.”

“The imbalances going into the crisis were large to begin with. Now, they are bigger than ever.”

George Soros, Chairman, Soros Fund Management:

“Bankers have too much power.” (Referring to the hold that Wall Street has over Washington.)

The “globalization of financial markets is built on false premises: namely, that markets can be left to their own devices.”

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Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation:

“Insured deposits are being used in ways that I don’t like to see.”

Wilbur L. Ross Jr., Chairman and Chief Executive Officer, WL Ross & Co.:

People were focused on “risk-ignoring rates of return.” (Describing one of the things that went helped bring about the financial crisis.)

If regulators had taken the time to visit a Countrywide Lending office, they would have seen something akin to “a Wall Street boiler room,” rather than a bank branch. (Referring to regulator’s unwillingness to go out into the field and see what was really going on during the housing boom.)

“Government is its own systemic risk in the mortgage market.”

Lawrence H. Summers, Director of the National Economic Council, The White House:

The root of most financial errors is “when you try to do today what you wished you had done yesterday.”

“I can assure you that on Main Street, it is a very different conversation.” (Referring to the contrast between the optimism on Wall Street and the more pessimistic mood of those struggling to get by in other parts of the country.)

“It is not the administrations’s view to bribe those who have been part of the problems we have experienced to do what is in the national interest.” (Referring to the suggestion that banks and other financial institutions need financial incentives to support proposed regulatory changes.)

Jeffrey D. Sachs, Director of The Earth Institute, Quetelet Professor of Sustainable Development, and Professor of Health Policy and Management, Columbia University:

“It was grotesque.” (Referring to fact that, despite its extraordinary size, the $62 trillion credit default swap market was essentially unregulated.)

“This was a crisis made in the U.S.” (Referring to the suggestion that China’s export policies played a key role in creating the credit bubble.)

Niall Ferguson, Laurence A. Tisch Professor of History, Harvard University, William Ziegler Professor of Business Administration, Harvard Business School:

“We are living though a gradual shift away from a dollar-centric system.”

“Is China the Germany of our time?” (Referring to the combination of economic dynamism and growing nationalism that stoked the aggressive ambitions of Nazi Germany.)

“The problem of being a declining empire doesn’t have a solution.” (Referring to the suggestion that a great many, if not all, of America’s problems are fixable.)

Robert J. Shiller, Arthur M. Okun Professor of Economics, Yale University:

“Look up ‘bubble’ in an economic textbook and it’s not there.” (Referring to the shortcomings of the traditional economic curriculum.).

People “are living in a ‘pretend-and-extend’ environment, waiting  for the economy to recover.” (Referring to the precarious state of the commercial real estate market and the wave of resets coming due between 2011 and 2013.)

Elizabeth Warren, Chair, TARP Congressional Oversight Panel:

“The reason banks lost confidence in each other is because they looked at their own books.” (Referring to the loss of confidence that roiled markets during the darkest days of the crisis.)

Source: Michael Panzer, October 16, 2009.

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The Road to Depression

Monday, December 1st, 2008


Brad DelongBrad DeLong says two big mistakes made the crisis worse:


James Bradford DeLong (b. June 24, 1960, Boston) commonly known as Brad DeLong, is a professor of economics at the University of California, Berkeley and a former Deputy Assistant Secretary of the United States Department of the Treasury in the Clinton Administration. He is also a research associate of the National Bureau of Economic Research, and is a visiting scholar at the Federal Reserve Bank of San Francisco.



The Road to Depression, by Brad DeLong, Project Syndicate: For 15 months, the United States Federal Reserve, assisted by the financial regulators of the US Treasury, have been trying…,

above all, to avoid a deep depression.

They have also had three subsidiary objectives:

  • Keep as much economic activity as possible under private-sector control, in order to ensure that what is produced is what consumers really want.
  • Prevent the princes of Wall Street … from profiting from the systemic risk that they created.
  • Ensure that homeowners and small investors do not absorb too much loss, for their only “crime” was to accept bad risks, which they would not have done in a world of properly diversified portfolios.

Now it is clear that the Fed and the Treasury have lost the game. If a depression is to be avoided, it will have to be the work of other arms of the government, with other tools and powers.

The failure to contain the crisis will ultimately be traced, I think, to excessive concern with the first two subsidiary objectives: reining in Wall Street princes and keeping economic decision-making private. Had the Fed and the Treasury given those two objectives their proper - subsidiary - weight, I suspect that we would not now be in this mess…

The desire to prevent the princes of Wall Street from profiting from the crisis was reflected in the Fed-Treasury decision to let Lehman Brothers collapse… The logic behind that decision was that, previously in the crisis, equity shareholders had been severely punished…

But this was not true of bondholders and counterparties, who were paid in full. The Fed and Treasury feared that the lesson being taught in the last half of 2007 and the first half of 2008 was that the US government guaranteed all the debt and transactions of every bank and bank-like entity that was regarded as too big to fail. That, the Fed and the Treasury believed, could not be healthy.

Lenders to very large overleveraged institutions had to have some incentive to calculate the risks. But that required, at some point, allowing some bank to fail…

In retrospect, this was a major mistake. … With that guarantee broken by Lehman Brothers’ collapse, every financial institution immediately sought to acquire a much greater capital cushion…,

but found it impossible to do so.

The Lehman Brothers bankruptcy created an extraordinary and immediate demand for additional bank capital, which the private sector could not supply.

It was at this point that the Treasury made the second mistake. Because it tried to keep the private sector private, it sought to avoid partial or full nationalization of the components of the banking system deemed too big to fail. In retrospect, the Treasury should have identified all such entities and started buying common stock in them - whether they liked it or not - until the crisis passed.

Yes, this is what might be called “lemon socialism,” creating grave dangers for corporate control, posing a threat of large-scale corruption, and establishing a precedent for intervention that could be very dangerous down the road.

But would that have been worse than what we face now? The failure to sacrifice the subsidiary objective of keeping the private sector private meant that the Fed and the Treasury lost their opportunity to attain the principal objective of avoiding depression.

Of course, hindsight is always easy. But if depression is to be avoided, it will be through old-fashioned Keynesian fiscal policy: the government must take a direct hand in boosting spending and deciding what goods and services will be in demand.


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Pershing Square Capital Management Releases Letter to U.S. Treasury Department Regarding Fannie Mae and Freddie Mac

Sunday, September 7th, 2008


Pershing Square Capital Management, L.P. sent the following letter September 6, 2008 (courtesy: BusinessWire) to the U.S. Treasury Department regarding Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE):

The Honorable Henry M. Paulson, Jr.

Secretary United States Department of the Treasury

1500 Pennsylvania Avenue, N.W.

Washington, D.C. 20220

Re: Fannie Mae/Freddie Mac Restructuring

 

Dear Secretary Paulson:

We understand that a Treasury plan for Fannie/Freddie (”the GSEs”) may be announced this weekend. We thought you might find useful some further thoughts on potential GSE solutions.

 

As you are likely aware, we had previously distributed a proposed restructuring plan for the GSEs. In that plan, under a prepackaged conservatorship, equity interests would be extinguished, subordinated debt would be exchanged for warrants, and senior debt would be exchanged for new senior debt and common equity in the newly recapitalized entities. The government would write a put to the new common equity holders which would expire in three years.

 

It appears, however, that the GSEs may need help more quickly, and conservatorship may not be triggered until the GSEs are formally determined to be undercapitalized. As such, in the event the government needs to inject capital immediately, we suggest you consider the following transaction (”the Transaction”).

 

In order to minimize risk to tax payers while being equitable to other constituents, we suggest that the Treasury consider purchasing senior subordinate debt in the two companies in an amount sufficient to address their capital needs in the short to intermediate term. This senior sub debt would be junior in right of payment to the outstanding senior unsecured debt and senior to the outstanding sub debt, preferred stock, and common equity. We refer to the outstanding sub debt, preferred and common stock as “the Subordinate Securities.”

The issuance of senior sub debt is permitted under the GSE legislation and under the existing terms of the outstanding debt and equity securities of the two entities (please see the attached memo for further details). As a condition of Treasury’s purchase of senior sub debt, the GSEs would defer the interest payments on the outstanding sub debt (which can be deferred for as much as five years), and the dividend payments on preferred and common stock. All of the Subordinate Securities would continue to remain outstanding according to their existing terms.

 

The new senior sub debt should have a market-based coupon and Treasury should receive low-strike price warrants (penny warrants) for a substantial portion, i.e., 49% of the two companies. The coupon and warrant structure should be as close to fair-market-value terms as possible. The ultimate determination of fairness would be the willingness of non-government investors to purchase the Transaction securities on the same basis as Treasury. As part of the Transaction, the GSEs would deleverage their capital structures by paying down senior debt from the free cash flow generated by their core businesses further improving the position of the new senior sub debt.

 

The benefits of the Transaction are as follows:

  • The Transaction can be accomplished under the existing terms of the outstanding GSE securities without any required consent other than from the GSEs.
  • The new security would be senior in right of payment to the existing sub debt and preferred stock minimizing the risk to tax payers while providing substantial support to the outstanding senior debt that has been deemed implicitly guaranteed by the government.
  • The new debt interest payments would be tax deductible, reducing the after-tax cost of capital to the GSEs, particularly when compared with preferred stock.
  • In the event the outlook and performance of the GSEs and their assets were to improve dramatically, the senior sub debt could be redeemed, distributions to the Subordinate Securities could resume, and their values would increase accordingly.
  • In the event that the GSEs’ fundamentals continued to deteriorate and they became undercapitalized, the GSEs could be placed in conservatorship. In conservatorship, their balance sheets could be restructured along the lines of our original plan or another plan with the Treasury’s senior sub debt treated preferentially to the Subordinate Securities, again minimizing risk to the tax payer.
  • The Transaction would be fundamentally fair to all constituents and would respect the existing terms and corporate hierarchy of all outstanding GSE securities.
  • The Transaction would minimize moral hazard issues for sub debt, preferred, and common stock investors.

 

Most importantly, we believe there are serious negative implications for other large financial institutions in the event the Treasury were to bail out Subordinate Security holders. The Treasury and OFHEO have done substantial research on the benefits to capital market discipline from large financial institutions’ issuance of subordinate debt, and the destructiveness of the government implicitly or explicitly guaranteeing such obligations.

 

See: Report to Congress “The Feasibility and Desirability of Mandatory Subordinated Debt“, Board of Governors of the Federal Reserve System and United States Department of the Treasury (December 2000), available at: www.federalreserve.gov/boarddocs/rptcongress/debt/subord_debt_2000.pdf

 

“Subordinated Debt Issuance by Fannie Mae and Freddie Mac“, Valerie L. Smith, Office of Federal Housing

Enterprise Oversight, OFHEO WORKING PAPERS, Working Paper 07 – 3 (June 2007), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1000264;

 

“Signals from the Markets for Fannie Mae and Freddie Mac Subordinated Debt“, Robert N. Collender, Samantha Roberts, Valerie L. Smith, Office of Federal Housing Enterprise Oversight, OFHEO WORKING PAPERS, Working Paper 07 – 4 (June 2007), available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1000240&rec=1&src abs=1000264;

(Due to its length, this URL may need to be copied/pasted into your Internet browser’s address field. Remove the extra space if one exists.)

 

“Subordinated Debt and Bank Capital Reform“, Douglas D. Evanoff, Federal Reserve Bank of Chicago, Larry D. Wall, Federal Reserve Bank of Atlanta, FRB Atlanta Working Paper No. 2000-24 (November 2000), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=252754.

 

To the extent the Treasury were to bail out the GSEs’ subordinate debt – which was: (1) never implicitly guaranteed by the government, (2) always rated below Triple A by the rating agencies, and (3) held by investors who knowingly took on the risk of loss in exchange for a substantial credit spread above the GSEs’ senior debt – it would endanger the systemic benefits from subordinate debt issuance for every highly leveraged banking institution in the world and the capital markets at large.

 

Furthermore, we do not believe that the Treasury can purchase GSE sub debt, preferred stock or common stock without incurring an immediate loss to tax payers because of the enormous amount of existing debt senior to these instruments. At a market coupon or dividend yield (to the extent that one were to exist), any debt issued pari passu to the existing sub debt, or preferred stock issued pari passu or even senior to the existing preferred stock would require a yield that would be uneconomic for the GSEs. No third-party investor would purchase these securities regardless of their terms in light of their junior position in the GSEs’ capital structure.

 

Please note that Pershing Square and affiliates own CDS on the subordinate debt of the GSEs. We also note that nearly all participants in the capital market debate on the GSEs are either long or short the outstanding GSE securities.

 

We are contemporaneously releasing this letter to the public in the interest of market transparency.

 

Respectfully,

 

William A. Ackman

 

Contacts

 

Pershing Square Capital Management, L.P.

William A. Ackman, 212-813-3700

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